How Collective Settlements Camouflage the Costs of Shareholder Lawsuits

78 Pages Posted: 12 Apr 2012 Last revised: 3 Oct 2012

Richard Squire

Fordham University School of Law

Date Written: April 12, 2012

Abstract

Corporations insure against liability in shareholder lawsuits by buying tiered coverage from multiple insurers who each cover a distinct segment of the potential damages range. Rather than negotiating to settle individually with the plaintiff, the insurers seek to reach a single, collectively binding settlement agreement. This combination of segmented coverage and collective settlements produces a conflict of interests: the corporation’s managers and some insurers are better off if the case settles pre-trial for the expected damages, while other insurers are better off going to trial. To force reluctant insurers to settle, courts have created a duty that can require an insurer to pay its policy amount when the plaintiff makes a settlement demand that exceeds that amount and another insurer or the corporation is willing to pay the rest. This “duty to contribute” biases negotiations toward settlements that overcompensate plaintiffs, thereby encouraging lawsuits of doubtful merit. The conflict of interests in settlement negotiations could be eliminated by allowing defense-side parties (defendants and their liability insurers) to settle separately their respective segments of the damages range. But this “segmented” approach to settlements is contrary to the private interests of managers because it eliminates the justification for the duty to contribute. That duty forces insurers to pay for settlements that they think are excessive or contractually uninsurable, thereby shielding corporate earnings reports — and managers’ incentive-base pay — from the costs of shareholder lawsuits resulting from the managers’ conduct.

Suggested Citation

Squire, Richard, How Collective Settlements Camouflage the Costs of Shareholder Lawsuits (April 12, 2012). 62 Duke Law Journal 1 (2012). Available at SSRN: https://ssrn.com/abstract=2039068

Richard C. Squire (Contact Author)

Fordham University School of Law ( email )

150 West 62nd Street
New York, NY 10023
United States
212-964-1584 (Phone)

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